January 21, 2011
Executive Compensation: Dark Matter, Unions, Social Norms, and Pay
Posted by Dave Hoffman

Just yesterday, Tony Jackson's FT column took the idea I had for this post, which was to praise my colleague Harwell Wells' wonderful paper "No Man Can Be Worth $1,000,000 a Year”: The Fight Over Executive Compensation in 1930s America.  In The Fight, Harwell explores the deep roots of concerns about pay, and suggests that the social norms of previous generations might have permitted significantly more radical constraints than the modest gruel served up by Say On Pay.

Having been preempted from praising the use of history to study compensation, I suppose I'll have to question it.  

One thing you sometimes hear from historians of compensation is that the managerial power hypothesis lacks explanatory power when considered over time.  Managers from the 40s-70s, despite having the same kind of power over boards to set their wages as they do today, didn't exercise it. Compensation was relatively stagnant. Because the law didn't much change, say historians, we must look to some other factor to explain the recent dramatic rise in managers' salaries.  That other factor: the strength of the union movement. It's the decline of unionism and its coincident egalitarian norms that has permitted managers to extract ever-higher salaries from firms.  Or so the story goes.

In a way, this explanation fits well with the left's dominant theory explaining the strikingly different fates of employment (awful) and corporate profits (terrific) in our jobless recovery.  Here's David Leonhardt in the Times:

"Relative to the situation in most other countries — or in this country for most of the last century — American employers operate with few restraints. Unions have withered, at least in the private sector, and courts have grown friendlier to business. Many companies can now come much closer to setting the terms of their relationship with employees, letting them go when they become a drag on profits and relying on remaining workers or temporary ones when business picks up."

The idea, then, is that a culture (societal or firm-specific) that is unionized is one where the managers pays a social penalty for having a salary that is vastly different from the line workers.  It's a bit of a variant on Robert Frank's theory about how the top earners in a firm must implicitly give up part of their salary to compensate the lowest earners for taking a status hit.  This idea about pay's structure is intuitively compelling, but it has a hole.  As Megan McArdle put it, "the decline of the labor movement is not an uncaused cause." She attributes the decline of unions - and the loss of a employment stability during recessions - to the rise of more economically competitive firms: 

"[When firms lost their "cosy oligopolies"] it made it much harder for labor unions to bargain: whatever arrangements they struck suddenly had to take customers, competitors, and shareholders into account, rather than simply arguing with management over their share of a relatively fixed pie.  This made unions much less valuable to workers; it also, independently, put pressure on companies to fire workers during downturns."
I'm not a labor economist, and I don't exactly know how one would evaluate these competing stories. But it strikes that there has to be a relationship between unionism, compensation, and some other factor - the dark matter comprising egalitarian social norms - that would help to explain why compensation remained stagnant until the 1980s.  There are tons of theories out there, and if we could test them, I doubt that we'd find law or legal rules to be a particularly dispositive part of the story. On the flip side, if executive compensation ever comes back to earth, it won't be because of a clever new disclosure regime.   (Hence, I think, the "deafening silence.")

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